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| Widening CAD (as % of GDP) in India (Credit: RBI) |
A lot of concerns are there regarding the CAD which has been on the rise and time and again the government has tried to come in with certain measures to check it. Finance Minister P Chidambaram has come up with slew of new measures to curb the CAD so as to strengthen the country's economy and check the weakening of Rupee's value versus dollar. What can we say about these measures?
There are twin deficits: 1) Current Account Deficit (CAD) and
2) Fiscal Deficit
Both these deficits are indicators of the health of our economy.
Fiscal deficit is the gap between the revenue and expenditure of the government for which the Finance Minister had in the last budget announced a number of steps by which we are trying to contain it. The second one which is creating a problem today which has been highlighted by the RBI in their recent policy review statement which they have called it "the dilemma" is the third challenge (apart from the growth and the inflation), the CAD.
Current Account Deficit is the deficit on our current foreign exchange receipts and foreign exchange payments. Basically it consists of trade deficit (the difference between the export and import), it composes of basket of remittances from Indians abroad, contains money coming through Financial institutions Foreign Institutional Investment (FII) or Foreign Direct Investment (FDI) etc. All that are reflected in the balance sheet maintained by the RBI and in the government and this indicates the health of the economy as far as the external vulnerability is concerned.
How does this work out and what exactly causes the CAD? What are its components?
Basic components will be import and exports. Imports means you will have to make payments in dollars (or Euros whatever). Now exporters when they sell the goods, they get the money in dollars (or in foreign exchange). So there exists a difference between the exports and imports and this is called the Trade Deficit. One of the reasons for our widening CAD is the gap or the trade deficit has increased that means our imports are becoming more than our exports.
But that hasn't been the case of Indian Economy by and large?
Yes, but of late it has gone due to the external environment, economic conditions globally, the demand has slumped. The exports from India are not picking up. So this demand is one factor. The second factors are the inherent factors of our competitiveness i.e., how much we have to match with our competitors like China, Thailand and Taiwan etc., and also factors like what is our technological range and the others about what is about our cost competitiveness. So all these factors are contributing to our exports which have not been growing so much as they should be. In July 2013, exports have increased 11.6% whereas, the imports have come down . Our exports were about $26 billion and our imports were $38 billion. So deficit became $13 billion which is 30% less than July last year. This is in a way heartening.
Apart from this Trade Deficit, the other things which go into our foreign exchange kitty are the remittances received from the Indians abroad, the money which is being put in the bonds or in the equity market by the FIIs. They are coming in a large number. But that money also goes out. Recent events have proved that this can be a risky, volatile nature of our composition. In fact if we see the financial stability report (FSR) which was issued by the RBI in June 2013, it shows a very interesting thing that our volatile composition of the total reserve is about 80%. Volatile means the money that will fly just like that. For example, if the US Fed Chairman announces something about reversing the policy, FIIs will find it better to take out the money and put it elsewhere which is not the case with FDI. FDI is qualitatively different from the FIIs. In FDI, the money comes and gets invested in a project or in trading whatever. So these are the two other components.
Foreign investment is also not very consistent of late. There have been some large scale projects where it was feared because of certain reasons, certain bottlenecks, some of the major projects have not taken off the way they should have taken off. Perhaps that should also remain a point of concern. So to what extent we are in a position currently vis-a-vis global scenario where we still remain an attractive market for investment in the country in projects so that we have our slightly stable foreign reserves?
The environment for attracting the FDI in India isn't too good. Government has taken a number of steps that we know like allowing 100% FDI through automatic route etc. So that open up multi-brand retail and removing restrictions on sourcing etc. Idea was that we should remove the obstructions or impediments which are resulted by the FDIs so that they can come. But the issue is not with regard to FDI, the issue is with regard to the CAD. Because the FDI will always have a timeline. If we relax our policies today let's say in aviation sector, then it will take time (maybe 6 months, a year or two years) but the money will flow. Where as in the FIIs, if the stock market is doing good, returns are good but the money will fly out also as easily. That's the difference between the FIIs and the FDIs. We regard FIIs with some kind of volatility as something that we can't depend upon.
FM talked about the non-destructive financing of the CAD of $70 billion. Basically he is taking of the liberalizing External Commercial Borrowings (ECBs). ECB is a commercial borrowing raised by the business entities in India from abroad through banks, creditors, through buyers credit etc. That helps them in managing their finances and comes in dollars. ECB up to $500 million is in automatic route. We have been liberalizing it and we have put caps that for different sectors there are caps. The ECB guidelines are being liberalized here and that forms a very important component of our Current Account. But ECB can also be risky. Because if you have contracted ECB, you have to make payment in dollars. If you haven't hedged that risk, because the moment you try to hedge it against the fluctuations, then your cost will be more, so quite a bit of ECB is not hedged. Now these are short term and this is another part of our current account deficit (CAD) which was alarming sounded by the RBI also consistently is that 44% of our short term liabilities is due short-term to the total debt on residual basis is about 44% and by March 2014, either of $130 billion or $135 billion has to be repaid. It is different thing that may rollover or they may continue with it but this is again volatile component of the CAD. So this is what CAD consists of.
So what is the way out other than what the FM has already announced? He has also proposed to keep under the check the buying of gold (by putting some restrictions on imports of gold), because people started purchasing gold as an alternative investment?
That is right. But then the point is that they are buying it as one time investment and that is why the last year's imports were 950 million tonnes, this year it came down to 850 million tonnes.
Can there be a mechanism where in people can invest in gold without actually requiring physical imports?
They have introduced some products exchange traded book bonds. Time has come now for us to really come out with some innovative financial products in the country so that our savings particularly the household savings get diverted from gold and real estate to the financial savings in those particular instruments. If bank deposits are giving negative return in rupees to the rate of inflation, we need to think of bonds such as inflation-indexed bonds. We need to have some kind of innovative reduction so that our household savings do not get diverted to gold. One of the measures that the FM has introduced is to compress the imports of gold and silver. Secondly he wanted to compress the demand for oil. It will happen only by making oil more expensive. Government is also trying to curb the imports of non-essential goods imports. That can be done very easily. In the short time, because of our specific challenge of CAD, Government should go wholeheartedly for that. But then the question will be what are essential and what are non-essential goods! Luxury goods for example can be curtailed in imports. But there is also counter argument that if you try to do this, it could lead to black marketing and other mischief in the indigenous market. But there's no way out. The other thing which is announced is public sector financial institutions to issue quasi sovereign bonds. Earlier there was a talk of government of India issuing sovereign bonds. But that is not being done now. What they have asked is that the Public Sector Financial Institutions will be allowed to issue sovereign bonds in dollar terms for infrastructure purposes so that they can get the money, foreign exchange will come and they would meet the demands, which is a step in the right direction.
What about NRI bonds?
There's no clarity whether the Quasi sovereign bonds will be guaranteed by the government of India. If they are guaranteed by the GOI, then it will add to the guarantee liability and to the Fiscal Deficit. May be in short-term they might do it.
What about checking the coal imports which are quite high and on the raise?
For curbing Coal imports, the only way to go is consider stop-gap measures. For example, when you are talking about exports, you need to improve the productivity, you need to have a labour law manufacturing competitiveness of our industry, the projects need to be triggered. If you don't have your infrastructure companies taking off, then there is no question of infrastructure leading companies issuing the sovereign bonds also since there is no requirement of money. So essentially what is needed is to take care domestically of the fundamental thing which is to revive the environment for investment and savings in the country. This is one crisis statement issued by the FM recently in the Parliament.
Will these measures really check the weakening of rupee in the short-term?
Let's see how does it go. They have proposed to meet $70 million on that. Perhaps apart from this, there will be several others measures announced by the Government which will be qualitatively oriented so that we really improve the strength of our country, our industrial production is going down, capital goods industry is down and now something is to be done to revive the investment sentiment in the country.
^This is a transcript of the Spotlight program broadcasted on AIR on 13/08/2013. It can be accessed here.
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